A political perfect storm for private equity

Policymakers and politicians have become increasingly aware of the remarkable rise of private equity. True to form, the Beltway has done its part to add growing pains to the growth of the industry. Throughout 2016 and 2017, during the runup to the Tax Cuts and Jobs Act, political crosshairs were set on the carried interest tax provision, which is integral to the industry model. And though private equity seemed to enjoy a political reprieve last year, it appears 2018 was the calm before a perfect storm of regulation, legislative hearings and presidential campaign trail rhetoric set to descend on the industry in coming months.

Indeed, the remainder of 2019 is expected to include finalization of the Committee on Foreign Investment in the United States (CFIUS) reform to mandate restrictions on foreign investors in private equity funds; another round of congressional hearings on systemic risk that will likely impugn the leveraged loans widely used to finance deals; and a cast of 2020 Democratic presidential candidates who have recently sharpened talking points that vilify the industry.

Instead of bracing for this storm, private equity should embrace it.

Along with industry growth, private equity has matured from its mid-90s Barbarians-era tactics into an asset class of responsible investors, largely dedicated to the long-term and aligned growth of the thousands of companies it collectively invests in, the implementation of environmental, social, and governance (ESG) standards within these businesses, and best-in-class long-term returns to investors—including public pensions.

If the industry now commits to public engagement, private equity leaders can not only navigate Washington, D.C., they can effectively shape policy and curb the increasing politicization of their industry.

Here’s how they can take on the multiple fronts coming their way:

Firms must be prepared to offer substantive input during the upcoming draft regulation period of CFIUS 2.0. The Foreign Investment Risk Review Modernization Act of 2018 has led to a pilot program—focused on “critical technologies”—for this reform. This program is well-known to fund managers with non-domestic investors, but details on key terms remain scant, as does the style—flexible guidance or clear instruction—in which the final rules will be written.

FIRRMA mandates full implementation of its provisions by early next year, indicating that draft regulation will be presented in coming months. Industry participants are likely to be given at least 30 days to review and provide comments to CFIUS once the draft is released. They should take full advantage of this Treasury-led opportunity.

On Capitol Hill, a more rudimentary explanation of industry operations may be necessary.

In the upcoming congressional session, the House Financial Services Subcommittee on Consumer Protection and Financial Institutions will convene to discuss threats to the U.S. financial system as a follow-up to their June hearing, titled, “Emerging Threats to Stability: Considering the Systemic Risk of Leveraged Lending.”

One would expect private equity—comprised of non-systemically risky firms and funds—to have been left out of the June debate.  Not so. Representative Alexandria O’Casio Cortez (D-NY) used her allotted time to highlight the unfortunate but unrelated Toys ‘R’ Us bankruptcy, blaming the company’s private equity sponsors.

If past is prologue, the industry can expect further distortions in the coming hearing. Executives can combat such disinformation by proactively contacting Congressional offices to explain the lack of systemic risk from the use of leveraged loans as part of their acquisition processes.

Lastly, the industry should be prepared to take on the loudest political critics of the industry, who will not be in Washington at all, but instead traversing early-voting states.

Senator Elizabeth Warren (D-MA) recently garnered headlines with her “Stop Wall Street Looting Act of 2019.” In effect, the bill aims to dismantle the private equity industry.  Similarly, Senator Bernie Sanders (I-VT), a co-sponsor of Senator Warren’s bill and longtime industry critic, recently reiterated his view that private equity is “destructive.”

Although the bill is not serious legislation—rather a political message to fit into the presidential candidate’s campaign—the danger with Warren’s bill, and both presidential candidates’ rhetoric, is the possibility for aspects of the bill to find their way into the emerging Democratic Platform.

This presents another opportunity for industry leaders to publicly highlight private equity’s transformation—this time across communities outside of Washington, D.C.

There is no time like today for the industry to embrace its increased profile and start reframing its perception. The effort might take strategy and resources, but a holistic long-term political engagement can change the industry narrative. Simply playing the odds, especially in politics, may prove costly in 15 short months. One need look no further than to the current Administration to remember the unexpected ways political sands shift.

James Maloney is the Founder & President of The JHM Group, a New York City-based financial services advisory firm. He can be reached at jamesmaloney@thejhmgroup.com or @JamesAMaloney.